Saturday, May 28, 2016
11:09:43 PM EDT

Semiconductors, Biotechs, Energy

by
Jim Brown

The three pillars supporting the market last week were the chips, energy stocks and biotechs.
Each of those sectors helped to power the Nasdaq, Russell 2000 and the NYSE Composite to 8-week highs. Considering the Dow was at an 8-week low just a week ago, that was no small feat. The week started out slow with the major indexes trading basically flat on Monday but Tuesday saw a gap higher on gains in Europe and that started a two day short squeeze on the news the Brexit vote was now solidly in favor of remaining in the EU. Financials rallied as various Fed heads continued to talk up the chances for a June rate hike.

The chip sector rose after Applied Materials said orders were at 15-year highs and raised their guidance significantly over analyst estimates. Following that news, a headline out of Asia said Apple had asked component suppliers to produce enough for 71-74 million iPhones in 2016. That lifted all the chip stocks that were Apple suppliers and the entire sector caught fire. The Semiconductor Index rallied to an 11 month high.

The biotech sector rallied to a 4.2% gain on expectations for the ASCO cancer conference that starts on Friday. This is an annual event where companies will make dozens of presentations on new drugs and cancer research that can change the future of the fight against cancer. Companies presenting novel new drugs or research that could lead to new therapies have been known to see their shares spike significantly. The sector found a bottom on the 12th and has been moving steadily higher ever since. This should last through next Friday and then the companies that fail to impress will be trashed the following week and that will be the large majority.

Energy stocks rallied as oil rose to $50 on Thursday. There was some immediate selling in the futures when that level was hit but the price still closed at $49.56 on Friday. Continued production outages around the world plus an inventory decline in the U.S. were responsible for the gains in crude. Now that the $50 level has been hit, we should see some of the excitement leave the sector. The next target is $55 and many analysts believe that will be hard to reach and have very little hang time as those outages are cured and U.S. producers begin to put rigs back to work.

The financial sector hit a five-month high on expectations for a June rate hike. Higher rates means banks can charge more for loans while their cost of deposited funds remains low. Even a 25 basis point hike is a 50% increase in the Fed funds rate. When you are talking about interest on trillions of dollars that is a lot of money.

The combination of those four sectors pushed the NYSE Composite much closer to strong resistance from 10500-10600. Those levels should be difficult to break but the NYSE is a broad 1,900 stock index that contains the large stocks like GE and XOM as well as hundreds of miniscule stocks that barely maintain enough market cap to remain listed. Therefore, it really takes a broad based rally to push it higher. If we remove one or two of those sectors mentioned above the May weakness will return.

The Russell 2000 Small Cap index exploded higher because all four of those outperforming sectors are big constituents of the index. The Russell erased a month of declines in only five days. However, there is significant resistance at 1155, 1165 and 1205. I seriously doubt it can continue to plow through those levels without any retracement.

The S&P-400 Midcap Index has broken out to nine-month highs and could continue its gains. This is the most bullish of all the index charts. If the midcaps continue to move higher, it could provide a spark for the broader indexes. The index is only 67 points from a new high.

The Nasdaq Composite benefitted from those four positive sectors but also from the FANG stocks. Facebook, Apple, Netflix and Google as well as Amazon were up strongly as were several other big cap tech stocks. The problem is whether they will continue the rally. Netflix was up +17 points over the last two weeks. Google was up almost $50 over the same period. How much longer can these gains continue?

Resistance at 4,968 is the next test followed by psychological resistance at 5,000. The Nasdaq is well below the November highs and it would take a monster rally to push the index to those highs.

The S&P-500 is entering a massive resistance zone and the next 33 points to a new high, or less than 1.5%, will be tough. There is serious resistance dating back a year and while it will not be impossible it will not be a cakewalk.

The Dow has a similar band of resistance from 17,925 to 18,165 where there will be plenty of potholes and the next two weeks may not be as easy as last week's +372 points. If we did add another 372 points we would be at a new high so everything is within easy reach under the right conditions.

The dollar will be a market and commodity headwind. The closer we get to the FOMC meeting the stronger the dollar will get. That is negative for equities, oil and gold. Declining oil prices will be negative for equities as well.

The Dow Transports struggled higher against rising oil prices thanks to the recovery in some airlines stocks and a rebound in the railroads. I believe this bounce will be short lived but never count them out.

High yield bonds continue to soar despite a record number of new issuance. The HYG is struggling to get back into the lead over the S&P and the impact of the bond market is being felt. The HYG always leads the S&P and should it move over the S&P it will be a major boost for equity sentiment.

The Semiconductor Index always leads the S&P at major turning points. Look closely at the blue line and you can see the relationship. The SOX averages about a 10-14 day lead over equities. The correlation is nearly 100%.

The short-term view is neutral. It was a good week for the bulls but it remains to be seen if it can continue. Once we get into June and the summer doldrums take hold the current market strength could fade and just turn into choppy trading for the summer as we wait on OPEC, the Fed and the political conventions in late July.